Selling A Business Organized As A "C" Corporation -- When It Is Not A Tax Problem -- Part 3

Some of the primary drivers of business sales are the tax preferences of buyers. A previous series of articles in this column addressed a range of ways of how the buyer affects the seller’s tax strategy. One of those preferences is a desire to reset asset depreciation values and schedules. That preference translates into the vast majority of business sales being “asset” sales as opposed to “stock” sales. For owners of “C” corporations, this is problematic. The sale of assets by the “C” corporation creates a tax liability for the business itself. Then, subsequent distribution of cash proceeds to the owner in the form of a dividend creates a tax liability for the owner her/himself. You have double-taxation.

In our first installment of this series, we noted that all is not lost. We saw that the US Tax Court has recognized the personal efforts and relationships of an owner are the personal assets of the individual and not the business itself. As such, you can sidestep double-taxation. In our second installment, we noted that certain types of assets – such as raw land and natural resources still attached to the land – are not depreciable. As such, a buyer need not require an “asset” sale because there is no depreciation value and schedule to reset . . . and a “stock” deal should be acceptable to a buyer.

We now turn to another scenario with similar circumstances: the technology start-up. Typically, the big asset of these companies is intellectual property. In the case of biotech or tech hardware manufacturing, including semiconductors, it is not uncommon that such companies are equipment intensive. But, often is the case that these companies lease such equipment rather than buy it. Thus, the big asset is intellectual property. And, all of a company’s development costs have likely been expensed. Given this, the intellectual property has a zero dollar cost basis. Further, the company’s book value is likely small.

If the buyer of your “C” corporation is another “C” corporation, the magic of Generally Accepted Accounting Principles (GAAP) kicks in for the buyer. This is irrespective of your own tax consequences. And, in the case of a target company (your firm) whose value primarily stems from zero-basis intellectual property, the buyer will get a depreciation reset even in the case of a “stock” deal.

When one “C” corporation wholly acquires another “C” corporation, the balance sheets are combined or “consolidated.” All of the assets of the target company become assets of the buyer. And, as we know, the buyer assumes the target company’s depreciation schedule. But, remember, the only meaningful asset of the target company is zero-basis/zero-book-value intellectual property.

Now, we have a little problem. The two corporate balance sheets are combined. And, the target company’s assets are basically zero . . . from a tax accounting perspective. How do we reconcile the fact that the buyer just paid $X for assets that have a book value of zero?

To the extent that the “C” corporation buyer pays more for a “C” corporation target company than the target’s book value, that excess is deemed goodwill on the buyer’s books . . . which is depreciable. Thus, in many technology start-up scenarios, if the buyer is a “C” corporation, it will likely not mind doing a “stock” deal. And, again, this is irrespective of your tax consequences.

Turning back to you, if a “C” corporation buyer pays for your company with its own shares AND the buyer is organized in a U.S. jurisdiction, assuming certain conditions, your tax liability will be deferred until you sell the shares of the buyer. To the extent you receive cash, you will have a taxable event. If the buyer is not organized in a U.S. jurisdiction, it will be deemed an “outbound conversion” and 100% will be deemed a taxable sale.

With proper planning and sufficient planning time, you might use certain types of trusts to reduce your ultimate tax burden related to your gain by as much as 75%. These strategies were discussed in a prior series of this column.

Hopefully, this series has given owners of “C” corporations a sense that there are some scenarios in which a buyer might not object to a “stock” deal . . . whether the buyer knows it or not. We have illustrated a few examples. Certainly, there are other circumstances. As always, the key is to start planning early. That “offer you can’t refuse” might come in six months. You want to have your choices already buttoned down. Knowing them might enhance your negotiating position.